Why Trade Deficits Matter

However one feels about Donald Trump, it’s fair to say he has usefully elevated a long-simmering issue in American political economy: the hardship faced by the families and communities who have lost out as jobs have shifted overseas. For decades, many politicians from both parties ignored the plight of these workers, offering them bromides about the benefits of free trade and yet another trade deal, this time with some “adjustment assistance.

One of Trump’s economic goals is to lower the U.S.’s trade deficit—which is to say, shrink the discrepancy between the value of the country’s imports and the value of its exports. Right now, the U.S. currently imports $460 billion more than it exports, meaning it has a trade deficit that works out to about 2.5 percent of GDP. Given that the job market is still not back to full strength and the U.S. has been losing manufacturing jobs—there are 60,000 fewer now than at the beginning of this year, according to the Bureau of Labor Statistics—economists would be wise to question their assumption that such a deficit is harmless.

Trump’s intention in reducing the deficit is to boost factory jobs, since America’s trade imbalance exists almost exclusively in manufactured goods. Putting aside how the Trump administration might go about this, is it smart economic policy? Is the U.S. trade deficit a problem whose solution would help American workers?

To start, it’s not inherently a problem for a country to have a trade deficit. For example, a fast-growing economy pulls in more imports as it expands, which pushes a country’s international trade account toward deficit. In that context a trade deficit is good for the economy, allowing the country to consume and invest more than if it maintained balanced trade. This was the story in 2000 when, after four years of strong growth, the American economy had an unemployment rate of 4 percent and a trade deficit that amounted to 3.7 percent of GDP.

But that story ended after the recession in 2001. The economy didn’t get back the jobs it lost in 2001 until January of 2005—then the slowest employment recovery since the Great Depression (it’s since been outdone in slowness by the recovery following the Great Recession). The trade deficit during this period continued to rise—the dollar was then over-valued, making U.S. goods less competitive internationally—eventually peaking at almost 6 percent of GDP in 2005 and 2006. In the early aughts, then, the growing deficit was not associated with a strong economy but a weak one.

In this context, the trade deficit was subtracting from demand in the domestic economy. Spending that could have employed people who needed jobs in the U.S. was instead employing people in Germany, China, and other countries from which America imports goods and services. In principle, the U.S. government could have looked to spur other channels of demand to offset the trade deficit, but as a practical matter this is often not easy to do: The most straightforward way to generate demand is through additional government spending, but there are major political obstacles to running large budget deficits even at times when it would be beneficial to the economy.

This problem became much worse as the economy faced a prolonged period of what economists call secular stagnation—meaning weak growth outside of a recession—in the years following the collapse of the housing bubble. While the U.S.’s trade deficit fell from its pre-recession peak, it has remained near 3 percent of GDP in the post-crash years. This deficit is a serious drain on demand, and does not stem from a strong economy pushing its limits. And with the Federal Reserve Board pushing interest rates down to zero, it had limited capacity to boost demand.

What effect does all this have on American workers? Trade deficits, even in times of strong growth, have negative, concentrated impacts on the quantity and quality of jobs in parts of the country where manufacturing employment diminishes. Even the economists who argue (incorrectly, we believe) that the trade deficit doesn’t affect the total number of jobs do admit that it affects the composition of jobs. There is, for example, a lot of research confirming that deindustrialization in the Rust Belt is partly a result of the fact that America meets its domestic demand for manufactured goods by importing more than it exports. One oft-cited academic study found that imbalanced trade with China led to the loss of more than 2 million U.S. jobs between 1991 and 2011, about half of which were in manufacturing (which worked out to 17 percent of manufacturing jobs overall during that time).* Further, the economist Josh Bivens found that in 2011 the cost of imbalanced trade with low-wage countries cost workers without college degrees 5.5 percent of their annual earnings (about $1,800). Far from a small, isolated group, these workers represent two-thirds of the American workforce.

And trade imbalances have repercussions far beyond the labor market. They can produce significant macroeconomic distortions, and those who view deficits as benign frequently overlook this. Most importantly, as Ben Bernanke noted over a decade ago, a trade deficit can have a role in producing financial-market bubbles and the devastation that’s caused when those bubbles burst. The problem arises when other countries suppress spending and investment, thereby boosting their savings rates and their trade surpluses. By the rules of basic accounting, those surpluses have to flow somewhere, and many flow into America. This further strengthens the demand for and value of the dollar, making American exports less competitive—and thus exacerbating the trade deficit. In the 2000s, these trade patterns helped provide the cheap capital that, in tandem with inattentive regulators, inflated the housing bubble. Almost a decade later, the country is still recovering.

Too many policymakers and their economic advisers have viewed trade deficits as harmless. Instead, at full employment, trade deficits mean the loss of good jobs, wages, and incomes for those in firms hit by competition from imports. In recent periods of weak demand, the trade deficit has been a drag on growth that’s not been offset by monetary or fiscal policy. And when other countries suppress the value of their currency to artificially cheapen their exports, all these problems in the U.S. get exacerbated.

By ignoring the downsides of imbalanced trade, many establishment politicians created an opening for a demagogue like Trump to offer an unrealistic nostalgia for a 1950s economy that existed before the modern, global era. In fact, international trade today yields many benefits for consumers and workers, both in the U.S. and abroad. On American shores, people have access to lower-cost and often better goods as a result of international trade. And abroad, exports to the U.S. have often been part of development strategies that raise standards of living.

The goal of trade policy should thus be to push back on U.S. trade deficits without distorting current trade flows. Large tariffs like the ones Trump has proposed won’t work, nor will preventing offshoring one company at a time, as he did with some of the jobs that the air-conditioning company Carrier was going to shift to Mexico. There are better ways to improve the U.S.’s trade balance—most importantly, the government could take steps to prevent America’s trading partners from manipulating their currencies to make their exports to the U.S. cheaper and the U.S.’s exports to them more expensive. But until economists recognize the costs of running a trade deficit in the first place, it’ll be hard for the country to address them.